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8.8.

98 EN Official Journal of the European Communities C 249/3

STATE AID
CØ33/98 (NNØ33/98)
Spain

(98/C 249/03)
(Text with EEA relevance)

(Articles 92 to 94 of the Treaty establishing the European Community)

Commission notice pursuant to Article 93(2) of the EC Treaty to other Member States and
other parties concerned regarding aid which Spain granted to Babcock Wilcox Espaýa SA

By means of the letter reproduced below, the Since this letter will be published in the Official Journal
Commission informed the Spanish Government of its of the European Communities, if the Spanish authorities
decision to open the Article 93(2) procedure. consider that some of the information contained in it is
confidential for reasons of professional secrecy, they are
requested to inform the Commission within 15 working
‘After examining the information provided by the
days from the date of this letter.
Spanish authorities, regarding aid granted to Babcock
Wilcox Espaýa SA, it has decided to initiate the
procedure provided for in Article 93(2) of the Treaty
The Commission would further inform the Spanish
with respect to the aid granted to Babcock consisting of
Government that, under the same procedure, it is giving
increases in the share capital in 1994 and 1997. The
the other Member States and third parties concerned
details of and reasons for the decision are set out in the
notice to submit their comments, by publishing a notice
Annex to this letter.
in the Official Journal of the European Communities. In
accordance with Protocol 27 to the Agreement on the
The Commission hereby gives the Spanish Government European Economic Area, it will also transmit a copy of
notice, as part of the Article 93(2) procedure, to submit this letter to the surveillance authority of the European
its comments within 30 days from the date of this letter Free Trade Association (EFTA) and will publish a notice
and to provide the Commission with any information it in the EEA supplement to the Official Journal. It will
considers necessary for the appraisal of the case. It invite that supervisory authority, the EFTA Member
would ask the Italian authorities to inform Babcock as States that are signatories to the Agreement on EEA and
soon as possible of the Commission Decision. interested parties to submit their comments.

Annex

1.ÙIntroduction

On 12 March 1997, the Commission received notification under the provision of Article 93(3) of the
Treaty, from the Spanish authorities, containing a project of restructuring aid in favour of Babcock Wilcox
Espaýa SA (hereinafter Babcock). On 18 March and 14 April 1997, during two meetings with the
Commission services, the Spanish authorities provided some additional information. However, by letter of
21 April 1997, the Commission services requested new information regarding the restructuring plan and the
viability prospects of the undertaking; a reminder was sent on 6 June 1997, asking in particular for
information concerncing the privatisation perspectives of the undertaking.

The Commission discovered, from the information submitted, that the undertaking received in 1994 from
its former shareholder TENEO a capital increase of ESP 10Ø000 million (ECU 61 million): this operation
was not notified to the Commission.

On 11 December 1997, the Commission services addressed a new letter to the Spanish authorities
requesting evidence on the status of the privatisation procedure and of the notified capital increase. The
Spanish authorities, by letter of 13 January 1998, confirmed that an adviser for the privatisation of the
undertaking had been selected but did not provide any evidence concerning the capital increase. The
C 249/4 EN Official Journal of the European Communities 8.8.98

Commission services requested detailed information on the capital increase by letters of 21 January and 12
February 1998. On 26 February 1998, the Spanish authorities communicated that the notified capital
increase in favour of Babcock had already taken place, notwithstanding the pending proceeding of the
Commission.

2.ÙDescription of Babcock Wilcox Espaýa SA

Babcock was constituted in 1918 as a limited company to design, construct and sell capital goods in the
form of spare parts or complete turnkey plants. In 1980, the company became part of the Spanish public
sector. It was formerly owned by TENEO SA, a subsidiary of INI (Instituto Nacional de Industria), which
was, in turn, entirely owned by the State. When INI was closed, its participation in Babcock was trans-
ferred to the new public holding SEPI, entirely controlled by the Spanish Government.

The Company has its head office in Bilbao, while its main production plant is located in Galindo. At the
end of 1996, it employed 1Ø518 people.

The undertaking operates in three main areas:

—Ùturnkey plants (paper, cement, iron, chemical),

—Ùenergy and environmental equipment (boilers, valves, gas treatment),

—Ùindustrial and metal processing equipment (furnaces, heaters, water steam circuits), both with internal
technologies and by licence agreements with major companies in the sector, such [.Ø.Ø.].

Babcock has suffered poor economic results for a long time. Although its financial figures are only
available to the Commission from 1993 onwards, it is possible to estimate that, in the previous years, the
undertaking posted significant losses: in 1993, in fact, it reduced its share capital to cover cumulative losses
of ESP 11Ø733 million (ECU 71 million). After 1993, the undertaking’s economic results are shown in
Table 1.

Table 1: Economic results of Babcock
(ESP million)

1993 (%) 1994 (%) 1995 (%) 1996 (%)

Turnover 36Ø556Ø 100,0Ø 43Ø301Ø 100,0 57Ø576Ø 100,0 43Ø391Ø 100,0Ø

Added-value 14Ø746Ø 40,3Ø 18Ø907Ø 43,7 16Ø268Ø 28,3 9Ø287Ø 21,4Ø

Personnel costs (8Ø382) 22,9Ø (12Ø751) 29,4 (9Ø450) 16,4 (11Ø263) 26,0Ø

Operating margin (519) (1,4) 187Ø 0,4 902Ø 1,6 (8Ø519) (19,6)

Financial charges (554) (360) (1Ø583) (565)

Extraordinary results 1Ø455Ø 763Ø 830Ø (19Ø946)

Net result 275Ø 0,7Ø 433Ø 1,0 107Ø 0,2 (21Ø810) (50,2)

Source: Babcock’s balance sheets.

In the period 1994 to 1996 about 50Ø% of the company’s turnover was generated in the energy and
environment business area, some 40Ø% in the turnkey business area and the remaining in the equipment
area.

As previously stated, the poor economic performance of its operations forced Babcock to reduce its share
capital in 1993 (in order to cover ESP 11Ø733 million losses accumulated by that time). Following this
reduction, on 20 September 1994, its former public shareholder TENEO granted Babcock a share capital
increase of ESP 10Ø000 million to restore a reasonably sound financial situation. Notwithstanding the
public nature of the funds involved, this operation was not notified to the Commission.
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The economic performance of the undertaking, however, did not improve after the capital increase. Both
in 1994 and 1995, the net profit obtained by Babcock did not reach 1Ø% of its turnover; in addition, these
slightly positive results were mainly due, in both years, to extraordinary positive revenues obtained through
the sale of some of the undertaking’s assets (ESP 672 million in 1994 and ESP 2Ø624 million in 1995).
Without this non-recurring and unpredictable revenue, both in 1994 and 1995, Babcock would have posted
significant losses.

The difficult economic and financial situation can be confirmed by the cash flow analysis for the years
1994 and 1995. In 1994, over 60Ø% of the cash proceeds of the undertaking were obtained from the capital
increase granted by TENEO; in 1995, only 1Ø% of the cash proceeds were obtained from normal
operations, the rest deriving from bank loans and asset sales: these circumstances show the very poor
economic performance of the undertaking.

During 1996, the economic performance of Babcock continued to worsen. Its operating margin became
strongly negative (about 20Ø% of revenue) and so did its net result. In order to cope with this difficult
situation, Babcock developed, in accordance with its sole shareholder SEPI, a restructuring plan based on
the following:

—Ùredirect company production and commercial effort to the turnkey systems business,

—Ùreorganise the company along the new strategic objectives,

—Ùsignificantly reduce operating costs by reducing the personnel (28Ø%) and the external costs.

According to the restructuring plan, the undertaking would incur ESP 14Ø500 million (ECU 88 million) of
extraordinary charges due to personnel reduction; these costs would be financed with ESP 10Ø000 million
(ECU 61 million) by the shareholder SEPI through a new capital increase and the remaining ESP 4Ø500
million (ECU 27 million) by Babcock itself with its internal resources.

The described restructuring plan and the related capital increase were notified by the Spanish authorities to
the Commission in order to assess whether State aid was involved and, if so, if it was compatible with the
common market. According to the Spanish authorities, no State aid is involved in the operation as:

—ÙSEPI is an autonomous entity not related to the public budget

—Ùthe operation would restore the profitability of Babcock, thus the investment should be considered as a
normal market operation of a private investor.

The Spanish authorities also claimed that, if the Commission were to assess the presence of State aid, such
aid would be compatible with the common market for the following reasons:

—Ùthe aid is granted under a restructuring plan introducing a significant reduction in production capacity
and aiming at the restoration of the company’s viability over a short time period,

—Ùthe aid is exclusively intended to finance the social costs of personnel reduction,

—Ùthe company is located in an Article 92(3)(c) region.

3.ÙDescription of the restructuring plan

Babcock’s restructuring plan, as notified by the Spanish authorities, was focused on three main actions:

—Ùreduction of operating costs,

—Ùrefocusing of the undertaking’s business areas,

—Ùincrease in the market penetration.
C 249/6 EN Official Journal of the European Communities 8.8.98

As to the first point, the plan foresaw a significant reduction in the undertaking’s production capacity, to
be achieved mainly by the reduction of personnel, as shown in Table 2:

Table 2: Reduction in Babcock’s production capacity

1996 1997 1998

Average employees 1Ø516 1Ø343 1Ø097

—Ùworkers 667 585 479

—Ùemployees 849 758 618

Available working hours 1Ø000Ø735 915Ø453 765Ø192

Cost of personnel (ESP million) 10Ø412 9Ø394 7Ø630

Source:ÙBabcock’s restructuring plan.

As shown, the restructuring plan submitted by the Spanish authorities foresaw a 28Ø% reduction in the
average workforce over three years, thus implying a 23Ø% reduction in the production capacity — in
available man-hours.

At the same time, the plan foresaw a 27Ø% reduction in personnel expenses, which would have dropped
from 22 (in 1996) to 14Ø% (in 1998) of the operating costs. Significant improvements were also foreseen in
the efficiency, as the plan was aimed at increasing the ‘‘income per employee’’ ratio by 71Ø% from 1996 to
1998 and the ‘‘added-value per employee’’ ratio by 40Ø% over the same period.

As to the remaining points, the restructuring plan foresaw some organisational and marketing actions
aimed at focusing the undertaking on its core business areas and specialising it in high profitable market
segments. Significant marketing efforts were planned in order to increase the worldwide presence of the
undertaking, with particular focus on fast-growing geographical markets such as Latin America and the Far
East. Such efforts were estimated by the submitted plan to produce a [.Ø.Ø.] increase in turnover over the
three years (from ESP 44Ø000 million in 1996 to [.Ø.Ø.] million in 1998).

Overall, the restructuring plan foresaw the restoration of the undertaking’s viability within the three-year
period, as shown in Table 3.

Table 3: Forescast of Babcock’s economic results
(ESP million)

1996 (%) 1997 (%) 1998 (%)

Turnover 43Ø391Ø [.Ø.Ø.] [.Ø.Ø.]

Added-value 9Ø287Ø 21,4Ø [.Ø.Ø.] [.Ø.Ø.] [.Ø.Ø.] [.Ø.Ø.]

Personnel costs (11Ø263) 26,0Ø [.Ø.Ø.] [.Ø.Ø.] [.Ø.Ø.] [.Ø.Ø.]

Operating margin (8Ø519) (19,6) [.Ø.Ø.] [.Ø.Ø.] [.Ø.Ø.] [.Ø.Ø.]

Financial charges (565) [.Ø.Ø.] [.Ø.Ø.]

Extraordinary results (n) (19Ø946) [.Ø.Ø.] [.Ø.Ø.]

Net result (21Ø810) (50,2) [.Ø.Ø.] [.Ø.Ø.] [.Ø.Ø.] [.Ø.Ø.]

Source:ÙBabcock’s restructuring plan.
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The restructuring plan involved an extraordinary cost of ESP 14Ø500 million (ECU 88 million) aimed at
financing an early retirement scheme for employees, thus allowing the reduction of the workforce. Such
cost was to be financed partly by Babcock (ESP 4Ø500 million) and the rest by the capital increase to be
granted by its shareholder SEPI.

However, the additional information submitted by the Spanish authorities on 26 February 1998, clarified
the actual costs incurred by Babcock for the reduction of its personnel as ESP 11Ø215 million (ECU 68
million), i.e. about 20Ø% lower than expected. Notwithstanding such lower costs, SEPI granted the capital
increase to Babcock of ESP 10Ø000, thus increasing its participation in the restructuring costs from the
forecast 69Ø% to the actual 87Ø%.

The capital increase has been executed notwithstanding the pending examination by the Commission; in
addition, it was communicated only as a result of an explicit request by the Commission services.

4.ÙAppraisal

In order to ascertain whether financial relations between the State and public undertakings involve aid
under the provisions of Article 92(1), the Commission analyses the financial flows in the light of the market
economy investor principle. In the case under assessment, it should be verified whether the funds granted
are State resources and, subsequently, whether these resources are being granted according to the defi-
nition of private market investor.

Since 1980, Babcock has been part of the Spanish public sector. At the time of the first capital increase in
1994, its share capital was 100Ø% controlled by TENEO, a subsidiary of INI which was, in turn, entirely
controlled by the Spanish Government. At present, Babcock is fully controlled by SEPI, a public holding
entirely owned by the Spanish Ministry of Industry, which granted the new capital provision.

Thus, the argument given by the Spanish authorities concerning the autonomy of SEPI from the State
budget cannot be upheld: any reduction in SEPI’s profitability (the same principle has to be applied to
former TENEO) due to losses of its controlled undertakings, such as Babcock, directly reduces the State’s
return on its investment in SEPI. Therefore, the financial resources granted by the Spanish Government,
through TENEO and SEPI, in 1994 (ESP 10Ø000 million) and in 1997 (ESP 10Ø000 million) to Babcock
constitute State resources; they therefore fall within the scope of Article 92(1), should they fail to pass the
market economy investor test.

According to the MEIP principleØ(Î), a financial transaction between a State and a public undertaking
involves aid as granted by a private investor operating under normal market economy conditions. This
principle implies, in particular, that financial measures granted by the State to its undertakings are not to
be considered as aid in the sense of Article 92, as long as the expected return on the funds is acceptable for
a private investor operating in normal market conditions.

On the other hand, should the economic and financial conditions of the company be such that a normal
return on investment is unlikely to be achieved in a reasonable time, the Commission assumes that the
financial support measures granted by the State to an undertaking would constitute State aid in the sense
of Article 92.

In the case under assessment, it is necessary to evaluate Babcock’s economic and financial situation in the
years preceding the proposed measures, as shown in Table 1, as well as the profitability prospects of the
restructuring plan as shown in Tables 2 and 3.

As regards the first capital increase in 1994, the figures in Table 1 show that the company’s operating
profitability has been largely insufficient, and even negative, over recent years. In addition, it is understood
that the capital increase followed a capital reduction in 1993 aimed at covering past losses which amount to
ESP 11Ø733 million. Also, the capital increase was not linked to any restructuring of the undertaking, as

(Î)ÙCommission communication on the application of Articles 92 and 93 of the EC Treaty and of Article 5 of Commission
Directive 80/723/EEC to public undertakings in the manufacturing sector (OJ C 307, 13.11.1993).
C 249/8 EN Official Journal of the European Communities 8.8.98

demonstrated by the poor economic performance of the following years. Therefore, the capital has to be
considered to have served only to cover losses.

In such situations, where ‘‘a normal return (in dividends or capital gains) cannot be expected within a
reasonable time from the capital invested’’, any financial support measure granted by the State is assumed
to contain State aid, as investments in such an undertaking would not be accepted by a private investor.
This appears to be the case of Babcock in 1994, as the company used to have a clearly insufficient
operating margin and was able to obtain a small net profit thanks only to extraordinary non-recurring
income. Under such circumstances, a private investor would not invest in the company, as the company
does not appear able to provide a proper return on such investment.

As regards the capital increase which was notified by the Spanish authorities and which was granted
notwithstanding the Commission proceeding pending, the figures in Table 1 show again that the company
remained largely unprofitable despite the capital increase of 1994. Both in 1994 and 1995, the company
was able to obtain a small net profit thanks only to extraordinary revenues, and in particular to sales of
assets, which cannot be considered as recurring revenue.

Even the strong increase in turnover of 1995 was not sufficient to restore Babcock’s viability. Despite a
30Ø% increase in turnover, the undertaking’s added-value dropped by over 10Ø%; its cash flow from
operations dropped to almost zero, thus showing the weak competitive position of the company. It appears
that Babcock was able to obtain such a large increase in its turnover only by cutting the profit margin on
its products and the inherent price undercutting, thus distorting the market. This fact, eventually, led the
undertaking to its current difficulties and required new financial intervention from its public shareholder.

A private investor would have either restructured the company long before reaching this situation or would
have decided on its liquidation. The decision of the Spanish Government to grant new funds to Babcock
instead of liquidating it appears to be related to considerations that cannot be regarded as normal market
investor behaviour. In fact, although no figures of possible liquidation costs have been provided, it can be
assumed that a private investor, when facing such a poor profitability record, would have been considering
the possibility of liquidating the company for a long time. The Spanish Government, on the contrary,
continued to keep the company operating and repeatedly granted funds despite its deteriorating economic
performance.

As regards the notified restructuring plan, the Commission raised some concerns related to the fact that
such a plan is largely based on increases of sales rather than on internal restructuring measures. In fact,
assuming, for 1998, a turnover similar to that obtained in 1996 and 1997, it appears that the company
would not be able to restore its viability. The possibility of obtaining a positive operating margin lies mainly
in the forecast 30Ø% increase in turnover in 1998, which, given the actual market conditions, appears
exhorbitant.

The Commission asked the Spanish authorities for appropriate evidence which could substantiate such an
optimistic evolution of the market position of Babcock: the information provided by the Spanish authorities
in this respect is insufficient. The Commission’s concerns for Babcock’s future viability have been substan-
tiated by the evolution of the relevant markets in the period following the notification: in the second half
of 1997, in fact, the crisis of the financial markets in East Asia reduced the growth prospects of that area,
where, according to the information submitted by the Spanish authorities, Babcock expected to obtain a
large part of its revenue.

In order to address the Commission’s concerns, the Spanish authorities proposed underpinning the profit-
ability prospects of Babcock with its privatisation; for this reason, they repeatedly assured the Commission
that a rapid sale of the undertaking to a private investor able to guarantee its viability had taken place. In
December 1997, the Commission services requested evidence of such privatisation and were answered by
the Spanish authorities that the sale procedure was still in a preliminary phase.

Also, during the Commission’s assessment, the Spanish authorities executed the capital increase in favour
of Babcock, without awaiting the final decision of the Commission.

Thus, the financial support measures in favour of Babcock, both the unnotified in 1994 and the notified in
1997, appear to contain State aid in the sense of Article 92. Also, having been granted without the approval
of the Commission, they are both illegal.
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Once apprised that the financial measures proposed by the Spanish authorities in favour of Babcock
contain State aid in the sense of Article 92(1), it is necessary to evaluate their impact on trade between
Member States.

In this respect, it is sufficient to note that the sectors in which Babcock operates experience a fierce
competition both at EU level and internationally. The sector of turnkey plants for energy production is also
facing a significant overcapacity due to the reduction of government expenditure in new projects; such
situations have worsened as a result of the recent events in East Asia.

Babcock itself is a large international company: a significant portion, between 50 and 60Ø%, of its revenue
in recent years has been obtained on the international markets within and outside the EU, where it is likely
that the company has competed with other EU competitors.

The aid granted to Babcock allowed the company to remain operational and enabled it to obtain new
contracts, thus reducing the market for its competitors not aided by other Member States and reducing
their revenue compared to what would have occured if Babcock had defaulted. This leads to the conclusion
that the aid appears to distort trade between Member States.

In conclusion, the resources granted to Babcock by the State constitute State aid in the sense of Article
92(1), as they derive from State resources and affect trade in the common market in the markets where
Babcock operates. In addition, having been granted without notification (for the 1994 increase) and
without waiting for the Commission decision on the notification (for the 1997 increase), they have to be
considered illegal.

5.ÙCompatibility with the common market

Article 92(2) and (3) provides some circumstances under which an aid could be declared compatible with
the common market.

Given the nature of the measures under assessment, Article 92(2) and 92(3)(b) of the Treaty cannot be
applied.

According to the Spanish authorities, the aid would be eligible for exemption under the provision of Article
92(3)(a), as the undertaking is located in an area classified as Objective 1 and suffering from serious
underemployment. However, the measures under assessment do not involve any investment in new
activities able to develop the economy of the region: indeed, they simply maintain operational an under-
taking which, otherwise, would be forced out of the market by other competitors. In this sense, they
appear not to qualify for the exemption provided for in Article 92(3)(a). Therefore, only the derogation of
Article 92(3)(c), in so far as it refers to the development of certain economic activities, can be applied. This
conclusion is reinforced by the fact that the Spanish authorities themselves notified one of the measures as
restructuring aid.

According to the relevant Commission guidelinesØ(Ï), restructuring aid can be declared compatible when it
fulfils five criteria:

—Ùit restores the long-term viability of the undertaking within a reasonable time scale,

—Ùit avoids undue distortion of competition, through reductions in the beneficiary’s production capacity,

—Ùit is kept to the minimum necessary to restructure the firm,

—Ùthe underlying restructuring plan is fully implemented,

—Ùperiodic monitoring reports on the advancement of the restructuring are submitted to the Commission.

(Ï)ÙCommunity guidelines on State aid for rescuing and restructuring firms in difficulty (OJ C 368, 23.12.1994).
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However, at this stage, the Commission has doubts that such conditions are respected, with particular
reference to the first three points.

Firstly, the funds granted in 1994 were not notified and, indeed, they appear to be operating aid as they
covered previous operational losses, in the absence of a coherent plan able to restore viability. The loss
compensation constitutes operating aid and has a particularly distorting effect on competition; in general, it
cannot benefit from the exemption of the provision of Article 92(3)(c) to be declared compatible.

Also, the Commission has doubts concerning the fact that the aid would be able to restore the firm’s
long-term viability, as, according to the restructuring plan originally submitted by the Spanish authorities, a
large part of the improvement in the economic performance of Babcock resulted from external measures
(e.g. increase in sales, etc.).

In addition, the aid appears not to be proportioned to the restructuring costs incurred by the company: the
original plan foresaw total restructuring costs of ESP 14Ø500 million, of which ESP 10Ø000 (about 69Ø%)
were to be financed by the aid. According to the information submitted by the Spanish authorities, the
actual costs incurred by Babcock have been only ESP 11Ø215 million, thus increasing the percentage of aid
coverage to 87Ø%.

Moreover, the funds granted in 1997 were provided without the preliminary clearance of the Commission
which was assessing the matter: in particular, the Commission had already raised serious doubts concerning
the undertaking’s prospects and the efficacy of the restructuring plan. Given these considerations on the
poor viability prospects and considering the subsequent worsening of the market, the aid granted to
Babcock appears, at this stage, incompatible with the common market.

6.ÙConclusion

Taking into account the above arguments and facts, the Commission has decided to initiate the procedure
provided for in Article 93(2) of the Treaty with respect to the aid granted to Babcock Wilcox consisting in
increases in the share capital in 1994 and in 1997.’

The Commission hereby gives the other Member States and other parties concerned notice to
submit their comments on the measures in question within 30 days of the publication of this
notice, to:
European Commission
Rue de la Loi/Wetstraat 200,
B-1049 Brussels.

The comments will be communicated to Spain.